Developing Capital Market Solutions for the Mortgage Market in
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Developing Capital Market Solutions for the Mortgage Market in Turkey Contents ▪ Need for a Capital Market solution for the mortgage market in Turkey – How to ensure a long term sustainable growth of the Turkish mortgage market ? – What are successful international examples ? – Is there local and/or international appetite for investing in such a market ? – Is the Turkish regulatory framework ready ? – What have been, so far, the main hurdles ? ▪ Proposed Capital Market solutions and key economics ▪ Summary of results from first meetings with key stakeholders ▪ Proposed implementation roadmap | 1 Capital market solution approach for mortgage market in Turkey – Key messages 1 Need for capital market solution 2 Proposed capital market solution 3 Economic feasibility 4 What we expect from stakeholders? A secondary mortgage market is required due to funding deficit in near future and maturity mismatch risk of deposits and mortgages ▪ Increasing loan-to-deposit ratio due to disproportionate growth in balance will result in funding deficit in the near future – (in 2013 and later on) ▪ More over, mortgages financed with short term deposits may lead to asset/liability incompatibility risk We are proposing a systematic solution for overcoming current obstacles in retail needs and kickstarting secondary mortgage market ▪ Current legislative framework in Turkey is compatible with most of the advanced standards and even today allows issuance of both covered bonds (which are more favored by investors) and RMBS; however some hurdles are constraining these issuance activities: (i) no real need for additional funding (ii) available data related to mortgage (iii) long issuing process (iv) limited volume insufficient for covering issuing costs ▪ Although banks can issue covered bonds today, a central issuing entity (CIE) is proposed as a solution in order to develop a standardized and organized approach ▪ Establishing such a central entity (a lean pass-through organization) will enable both retail and multi originator issuances and this will lead to (i) decreasing process complexity (ii) creating volume (iii) creating a broader investor base and (iv) increasing reliability of market Issuing will be more attractive in specific market conditions especially when liquidity problems emerge ▪ In current market conditions, covered bond economies within CIE are highly attractive (even today): 100 bps net yield and 200-220 bps additional yield by revaluing issuance revenues ▪ These yields will become more attractive in a scenario where liquidity problems emerge Participation of main stakeholders is important for kick-starting the market ▪ Support of market players is a critical prerequisite for capital market solutions ▪ Banks need to announce their participation, contribute to capital during CIE establishment process and assign representatives for the steering committee ▪ Just like the examples in foreign markets, participation of the government and some incentives are supplementary elements in establishing and kick-starting mortgage market | 2 The need for a Capital Market solution for the Turkish mortgage market has been assessed under several angles – key questions How to ensure a long term A sustainable growth of the Turkish mortgage market ? ▪ ▪ ▪ ▪ What are successful B international examples? Is there local and/or C international appetite for investing in such a market ? ▪ ▪ ▪ ▪ ▪ ▪ Is the Turkish regulatory D framework ready ? ▪ ▪ What have been, so far, the E main hurdles ? ▪ How has been Turkish mortgage market growing compared to its peers? How is it expected to grow? How are assets/liabilities of Turkish banks developing? Can expected deposit growth sustain the increase in mortgage volumes? What would be the additional funding requirement for banking sector? What would be the volume potential of a secondary market? What are the success stories of secondary mortgage market in the world? Are there any common themes among them? What are the roles of key stakeholders, government, banks, etc.? How are the systems in successful countries running? What are the key success factors? What kind of investor base is required to kick start and sustainably develop this market? What do critical investors think about possible secondary mortgage market products issued in Turkey? Are there any possible concerns of investors? How can these concerns be addressed? Two potential Capital Market solutions (i.e., “individual” solution and “system” solution) – not mutually exclusive – can be leveraged in order to develop a healthy secondary mortgage market Do the regulatory framework exist for governing primary and secondary mortgage market in Turkey? What are potential pitfalls or uncertainties in the law that would pose a threat in establishing the market? How did Şekerbank, the only covered bond issuance in Turkey, go in terms of process and timing? What should be done to overcome the main hurdles observed in Şekerbank issuance, problems observed in other examples and concerns of banks? | 3 Contents ▪ Need for a Capital Market solution for the mortgage market in Turkey – How to ensure a long term sustainable growth of the Turkish mortgage market ? – What are successful international examples ? – Is there local and/or international appetite for investing in such a market ? – Is the Turkish regulatory framework ready ? – What have been, so far, the main hurdles ? ▪ Proposed Capital Market solutions and key economics ▪ Summary of results from first meetings with key stakeholders ▪ Proposed implementation roadmap | 4 Residential mortgage lending in Turkey has significantly grown since 2005 Outstanding residential mortgage volume by banks Euro billion Turkish housing sector has seen a major growth starting from 2005, under the boost provided by multiple factors, e.g., ▪ ▪ ▪ ▪ ▪ Growing population Decreasing interest rates Increasing personal wealth +76% Number of loans ‘000 SOURCE: Banks Association of Turkey 17.4 19.8 26.4 7.8 11.9 2004 2005 2006 2007 2008 2009 3Q 2010 107 316 491 681 762 974 1,013 0.5 1.3 2003 42 New residential mortgage inflows by banks Euro billion +54% Rising urbanization process Development of the legal framework on mortgages 18.0 Number of loans ‘000 7.8 8.7 8.7 8.1 9.9 10.5 0.5 1.5 2003 2004 2005 2006 2007 2008 2009 3Q 2010 27 100 272 268 241 237 337 301 | 5 On the other hand, mortgages are still not the key source of financing for housing growth Turkey real estate sales between 2000-2010 Billion TL New mortgage sales 75.9 67.7 54.8 CAGR1: 31% 33.1 46.9 38.0 24.3 14.8 17.4 5.1 7.4 13% 1% 2% 5% 11% 2000 01 02 03 04 39% 41% 33% 28% 05 06 07 08 32% 09 42% 2010 1 Inflation between 2000-2010 has been 15.5% on average per year SOURCE : Banks Association of Turkey | 6 In fact many banks are financing residential housing with short-term financial products 2006 0-1 years 1-3 years 0.4% 27.9% 5-10 years 2008 0.4% 7.5% 3-5 years 10-15 years 2007 35.8% 14.8% 0.3% 7.2% 34.2% 26.6% 46.1% 2.2% 18.1% 2.0% 20+ years 1.1% 0.9% 30.9% 24.4% 15.7% 1.9% 0.8% 35.5% 6.8% 49.6% 0.1% 32.5% 5.7% 26.6% 48.4% 14.3% 19.5% 2011 YTD 0.2% 28.3% 16.8% 18.6% 2010 0.4% 6.2% 47.2% 15-20 years 2009 21.9% 52.6% 14.0% 26.1% 4.1% 54.0% 18.9% 1.2% 16.1% 0.6% 14.9% 0.5% 0.6% 0.3% 0.5% Total mortgage size TL billions 22.1 30.7 37.3 42.7 57.6 68.6 Avg. mortgage duration1 years 7.2 7.3 7.4 7.0 7.0 7.6 1 Based on original term duration of outstanding mortgages volumes; LTV can be at most 75% enforced by current regulation SOURCE : TCMB | 7 19.9% Banking sector will be in need of a secondary mortgage market in near future TL billion Mortgage market in Turkey will continue growing rapidly and this will cause maturity mismatch between assets and liabilities to gain more importance Disproportionate balance growth which causes funding deficit will create need for alternative funding Nominal GDP 3,000 1,100 450 60 2010 1,950 Mortgage balance 220 Balance sheet of Turkish banking sector x A Additional funding requirement TL billion 2010 2015 2020 Mortgage penetration 2010 2015 2020 11% 16% -50 1 -21 4,000 -32 -63 -71 -90 -100 -200 -89 -90 4,500 1,007 -80 Banking sector’s need for additional funding -111 -146 -187 -190 -188 2012 Turkey will keep up with Eastern Europe’s current level ▪ Additional funding will be required in 2013 – 2014 Real estate growth in Turkey (estimated to be over 10%) is driving mortgage growth Current maturity mismatch between mortgages (~7.5 years on average) and liabilities (~3 month on average) will grow more due to mortgage growth ▪ Crisis in Europe will increase the urgency SOURCE : BRSA, ECB 872 -45 -65 -174 ▪ L -14 -150 2010 2015 2020 A L 50 0 5% ▪ 2020 2020 135 ▪ ▪ E 400 E Estimated deposit growth with ~15% CAGR vs. credit growth with ~18% CAGR Level of equity is assumed to cover minimum capital efficiency ratio | 8 DEMAND ANALYSIS Outstanding mortgage volume trend is expected to follow Eastern European countries Outstanding mortgage volume penetration over GDP Percent 16 Poland 4 4 5 6 2002 03 04 05 8 06 18 19 21 12 Outstanding mortgage volume penetration projections 07 08 09 10 16 2011 11 19 Czech Rep. 2 3 4 6 2002 03 04 05 6 Hungary 2002 8 03 10 04 10 05 7 06 10 19 19 5 11 Turkey 12 06 07 13 07 08 15 08 09 10 2011 17 16 17 09 10 2011 2 05 10 15 20 ▪ Turkey lags behind the Eastern European countries in mortgage penetration over GDP ▪ Mortgage penetration for Turkey has been simulated to come close to current Eastern European penetration by 2020 | 9 DEMAND ANALYSIS Mortgage demand growth is also supported by estimated real estate sector projection Housing transaction value TL billions Mortgage volume issued +10% CAGR 192 Methodology 67 CAGR 121 77 56 ▪ 125 45 ▪ 21% ▪ The breakdown of first hand, second hand and project stage housing sales are estimated Publically available data1 is used to calculate base market size Global Insight real estate growth are incorporated for projections 65 32 New mortgage penetration Percent 2010 2015 2020 41% 54% 65% 1 TÜİK, GYODER, Garanti Reidin, Global Insight databases are used SOURCE: Global Insight, TBB, GYODER, TÜİK, Garanti Reidin | 10 OFFER ANALYSIS We inserted our mortgage demand projections into the balance sheets and calculated additional funding requirement of banks in the future TL billions Liabilities Assets Deposits Other assets 4,545 3,955 Other liabilities Securities 2,098 Other loans 352 50 872 Mortgage 2005 ▪ 2,422 10 15 Additional funding requirement 2020 Deposit growth catches loan growth around 2015 with increasing wealth of the population and sophisticated banking products 0 -50 1 -21 -14 -32 -100 -200 Equity ▪ ▪ 10 -89 15 2020 Strong loan growth with even a stronger outstanding mortgage volume growth is expected, loan growth slows down after 2014 Mortgage is the highest growth loan product with ~23% CAGR until 2020 -146 2005 ▪ 135 10 2020 Equity is assumed to be keeping the capital adequecy ratio at minimum 2012 2020 Scenario 1: Payables to other banks, money market and central bank keep its current 24% levels ▪ Scenario 2: Payables to other banks, money market and central bank increase up to 26% through higher levels of debt 213 15 -187 -190 -188 ▪ 402 55 -90 -80 -111 -174 Additional funding 407 2005 -63 -71 -90 -150 1,007 -45 -65 | 11 More over, if economic conditions in Europe would deteriorate further, funding from foreign banks is likely to suffer and escalate the funding gap even worse Declining volumes of bonds issuance from Eurozone1 banks … … forcing the European Central Bank to steadily inject liquidity into the system ECB lending to peripheral Eurozone countries has increased in the year as GIIPS banks find it harder to access liquidity 616 Greece Spain Ireland Italy Portugal -12% p.a. €’bn 572 473 2009 2010 20112 Mar08 Sep Mar09 Sep Mar10 Sep Facing stressed funding conditions, Euro banks are implementing hard measures: ▪ Deleveraging of less profitable businesses ▪ Holding positions (rather than growing) on more profitable and on strategic businesses ▪ Enforcing selffinancing policies for any foreign subsidiary/activity Mar- Jul 11 1 Eurozone includes all countries which use the currency Euro 2 2011 numbers estimated by annualizing the bond issuances till 14th Dec 2011 SOURCE: Dealogic, European Central Bank (ECB); Central Banks of Countries, press clippings | 12 Hence, capital market solutions for mortgage market could become a tool to mitigate the liquidity concerns and funding gap Solution Description Key features ▪ ▪ Covered bonds are issued by bank and have recourse, both to the cover pool and to the issuer ▪ Preferential claim of the covered bondholders against a dedicated pool of mortgage collateral (“cover pool”) Covered bond In order to support housing demand and mitigate the funding mismatch there are two alternative (not mutally exclusive) capital market solutions On-balance sheet instrument issued by the bank ▪ Covered bonds are backed by a revolving/dynamic pool of qualifying collateral (credit quality and size, will drive over-collateralization requirements) Key benefits ▪ ▪ ▪ ▪ RMBS Off-balance sheet ▪ instruments issued by a SPV (Special ▪ Purpose Vehicle) Acquisition by the SPV of a pool of mortgage loans originated by a bank ▪ Interest and principal payment to note-holders according to cash-flows generated by the underlying loans (typically non-recourse to originating bank) SPV finances the acquisition issuing mortgage backed securities to be placed with domestic and international investors ▪ Additional source of liquidity to fund new mortgages origination Benefit from cheaper funding rates compared to more traditional funding sources Distribution of risk to a new investor base with consequent reduction of regulatory capital requirements (RMBS) Asset portfolio optimization | 13 Contents ▪ Need for a Capital Market solution for the mortgage market in Turkey – How to ensure a long term sustainable growth of the Turkish mortgage market ? – What are successful international examples ? – Is there local and/or international appetite for investing in such a market ? – Is the Turkish regulatory framework ready ? – What have been, so far, the main hurdles ? ▪ Proposed Capital Market solutions and key economics ▪ Summary of results from first meetings with key stakeholders ▪ Proposed implementation roadmap | 14 Multiple variations of covered bond and RMBS market models may be available for Turkey Examples explored Why is relevant for Turkey? Danish model Covered bonds French model Mexican adaptation ▪ ▪ Limited and mainly local secondary market Mortgage banks do not bear any substantial currency, liquidity or interest rate risk ▪ ▪ Central solution to issue covered bonds Government support at the start phase to create covered bond market ▪ ▪ Successful adaptation of Danish balance principle to RMBS products as well Recently, efforts in place to expand into covered bonds Hybrid Malaysian model (Cagamas) RMBS Italian (BCC) model ▪ ▪ Flexible model between on- and off-balance sheet Addressing both liquidity and risk management via purchase with and without recourse, respectively ▪ Multi-originator scheme helps overcome small banks’ scale hurdle These models have been (in some cases) supported by regulatory incentives, especially in the initial phases | 15 Being one of the world’s largest covered bond markets, Denmark is considered to have a very robust mortgage system for over 2 centuries Danish mortgage model ▪ ▪ ▪ ▪ ▪ ▪ ▪ Danish mortgage market is considered world’s most robust mortgage system with its 200 years of history and success during multiple world crisis 2nd largest covered bond market in EU after Germany Most of mortgages issues by Mortgage Banks, main lending operators Mortgage loan originators issue covered bond to finance their loans Covered bonds are issued and sold on a daily basis simultaneously with the fixing of final terms of granted loans (tap issuance). Final terms of granted loans are fixed within the terms of the issued covered bonds. Loans are not granted if mortgage banks can not obtain the relevant covered bond funding Covered bonds are traded in the Copenhagen Stock Exchange (OMX) Investors and issuers register their trades at VP Securities Services which provides technology to the whole system SOURCE: Nykredit; Danish Mortgage Bank Association, VP Issuers Mortgage Banks Report trades Book entry forum Telecommunication market (OTC) Copenhagen Stock Exchange VP Securities Services Market participants Investors Report trades Registration of trades | 16 The Danish mortgage model is based on 3 main pillars (3-S) Speed ▪ ▪ ▪ ▪ Mortgage Banks fund loans on a current basis, i.e. bonds are not sold until the loan is disbursed to the borrower As Mortgage Banks grant new loans daily, they also issue new bonds daily Simultaneous issuance of mortgage loans and covered bonds is called “tap issuance” The market price of bonds at the time of sale consequently determines the loan rate Security ▪ 3 ▪ 1 ▪ 2 Mortgage loans and covered bonds are matched for perfect balance of cash flows Borrowers are protected against market risk through the “Balance Principle” Borrower has always the option to prepay by – Buying the bonds at par – Buying the bonds from the same ISIN at market price Loan: 5% interest rate, 30year term Bonds: 5% interest rate, 30-year maturity Standardization ▪ ▪ ▪ ▪ Supply of loan products is standardized, i.e. the borrower has a limited option of loans with predetermined loan type1, term, currency, amortization profile, etc. Uniform mortgage loans enable uniform covered bonds from same issuers with identical coupon, maturity, type of amortization for the same product type1 These uniform bonds are grouped into the same International Securities Identification Number (ISIN) which is priced by the investors Supply of large quantities of uniform mortgage bonds ensures liquidity of the market, hence bonds are generally attractively priced by the market ensuring low interest rates for the borrowers 1 That is, fixed rate loan, AMR, floating rate loans SOURCE: “The traditional Danish mortgage model” by Realkreditradet; LatinFinance | 17 Danish mortgage bond market has an efficient and effective operating model Loan and bond issuance Payments 1 Loan application ▪ 5 Regular payments apply1 Customers for mortgage loans specifying characteristics, such as maturity, coupon, etc. (example, 1 million DKK mortgage, 10 years maturity, 10% coupon rate) ▪ 1 Bank 4 2 Bond issuance ▪ 4 Loan originate ▪ Borrowers ▪ 2 Loans are finalized based on market pricing Borrower receives cash ▪ With tap issuance, bonds are issued same day Bonds corresponding to loans with same characteristics are grouped into ISINs Investors 3 6 Prepayment ▪ Borrower pays principal and coupon payments to the bank which transfers them to the investors Barrower pays commission to the bank (usually 0.5% annually of the outstanding debt) ▪ 5 Barrower has always the option to prepay by – Buying bonds at par – Buying bonds at market price 3 Bidding 6 Copenhagen Stock Exchange ▪ Investors bid on the bonds and the market determines the yield rate of bonds, hence interest rates of loans 1 Assuming credit underwriting process and scoring are already completed SOURCE: Denmark Mortgage Bank Association | 18 Caisse de Refinancement l’Habitat (CRH) is a refinancing center for French banks’ mortgages Background ▪ ▪ ▪ ▪ ▪ ▪ ▪ ▪ Created in 1985 by French government with State guarantee1 for refinancing of mortgages granted by French banking system Credit institution licensed to operate as a financial company by French Credit Institutions Committee Today, instead of state guarantee, very strong privilege to CRH’s bondholders on CRH’s secured loans to Banks Capital of CRH is owned by French banks According to law, CRH needs to abide by capital adequacy requirements Capital adequacy ratio under Basel I and Basel II is 8.67% Capital stock is reallocated between banks every year, on 31st March, so that banks have capital in proportion with their loans Banks have voting power in proportion with their shares in equity CRH bond issuances between 2000-10 Billion € Number of issuances 9.2 7.7 8.3 7.4 5.1 2.6 2.6 1.4 2000 01 9 9 3.1 1.8 1.8 02 9 03 8 04 05 9 10 06 12 07 14 08 6 09 2010 15 17 1 Until 1988 SOURCE: CRH | 19 CRH is a lean organization with major French banks as its shareholders Organization chart of CRH Breakdown of CRH equity 2010 2011, Percent Board of Directors Audit Committee Compensation Committee Chairman General Secretary ▪ ▪ Members of these committees are coming from founder banks Administration and Accounting In total 9 people is fulltime employed at CRH SOURCE: CRH Inspection 39.7% Crédit Mutuel CIC 35.2% Société Générale 10.9% BNP Paribas 8.7% BPCE 4.7% Others 0.8% CRH shareholders make up 90% of French mortgage market Equity is allocated depending on the outstanding loans Roles & responsibilities of shareholders ▪ ▪ Finance and Communications Crédit Agricole SA – Crédit Lyonnais ▪ Capital commitments – each bank must supply enough equity/subordinated loans to meet CRH capital adequacy requirements depending on its share of CRH loans Cash advances – Each stockholder must supply CRH with the amounts in the form of cash advances, required for its operation, subject to a limit of 5% of outstanding loans Board of directors – Each stockholder has a director in the CRH Board with following key responsibilities – Setting maximum level, terms and conditions of bond issuances – Monitoring CRH activities, reviewing and approval of financial reports | 20 There is an exact matching of CRH loans to banks and CRH bonds issued Value stream of key stakeholders Description 1 Bondholders 1 Bond issuance by CRH ▪ Bond issuance 2 Loan issuance CRH 3 2 ▪ ▪ CRH loans to banks ▪ CRH loans to banks have the same characteristics as those of CRH bonds, i.e. term and maturity perfectly match ▪ Refinanced loans constitute collaterals (with minimum 25% overcollateralization, 50% if floating rate1) for the notes Banks give to CRH in exchange for CRH loans Refinanced loans stay on the balance sheet of borrowing banks Loans pledged must at all times have an average life nearby to the residual life of principal note secured, and bear interest at an average rate equal to or higher than that on the note In case of insufficient collaterals due to refinancing of mortgage holder default, borrower bank needs to add enough collateral to the pool or buy enough bonds from the bondholders and deliver these bonds to CRH Only residential loans under 25 years and 1 million € Collaterals ▪ Banks 3 Mortgages to individuals ▪ ▪ Mortgage owners Substantially all of CRH bonds are issued at fixed interest rate Rated Aaa and AAA by Moody’s and Fitch Repo eligible with European Central Bank and French Central Bank ▪ 1 90% of mortgage loans in the market are fixed rate SOURCE: CRH | 21 Effective recourse mechanisms and shareholder banks’ responsibilities significantly reduces investor risk ▪ Bank A Bank B Bank C Bank D ▪ Shareholder banks must immediately supply CRM with cash advance up to 5% of outstanding loans to ensure timely payments If CRH experiences difficulty to satisfy the claims of bondholders, shareholders are required to allocate additional equity to CRH CRH ▪ Bank E (defaulted) ▪ ▪ SOURCE: CRH Full ownership of collaterals is taken by CRH (Maturity dates, mortgage notes lapses in favor of CRH) If collateral insufficient, CRH has recourse to defaulted bank as unsecured creditor ▪ CRH has full responsibility to ensure timely payments to bondholders In case of CRH voluntary or courtordered liquidation, capital contributions (equity and subordinated loans) of stakeholders are not repaid until all other creditors are paid in full Investors Credit risk is a risk on the French Banking System instead of individual originators | 22 Mexico, as an emerging mortgage market, has succesfully adapted Danish model to RMBS SOURCE: SHF; The Economist; LatinFinance, VP ▪ Danish mortgage model is adapted to Mexico to improve access to mortgage financing and increase private homeownership in Mexico ▪ Soros Foundation and Danish Central Security Depository initiated a company called HipotecariaTotal (HiTo) for this project ▪ VP Securities and Soros Foundation run Absalon Project to bring technology and consulting services ▪ HiTo’s mission is make the home financing mechanisms readily available to all the Mexican people by cutting down the funding costs of the Originators by providing technological systems, consulting, management, marketing in order to strengthen and facilitate the origination and issuance of covered bonds ▪ HiTo is a private company, and does not regulate, originate, promote or guarantee the Loans ▪ Danish model (“balance principle”) is applied to the RMBS market of Mexico ▪ Since its foundation, HiTo issued 100 million USD RMBS based on Danish model | 23 Central solution (Hito) in Mexico enables also individual issuances utilizing all benefits of the system solution From … … to Mortgage banks (Sofoles) requests funding SHF (Sociedad Hipotecaria Fund) gives funding Sofoles grants mortgage loans and accumulates them Securitization if market conditions permit 7 months due to complexity Small mortgage banks Large bank or Sofol HiTo 28 months due to scale Multi-sofol securities Single-originator securities Theoretically 1 week, practically 1 quarter due to scale Securitization With simple interfaces and efficient integration of technology, small mortgage banks can access capital markets to fund their mortgage loans continuously at low cost and high speed SOURCE: SHF | 24 Market context when Cagamas has been established Market context ▪ Establishment of Cagamas. Main shareholders are – 20% Central Bank of Malaysia – 80% Commercial and Investment Banks ▪ Financial Institution faced tight liquidity situation in the mid 80s: – Limited source of funding (deposits & equity) – Funding mismatch – short term deposits to fund long-term housing loans – Deteriorating loan to deposit ratio – Inability to source for long term funding ▪ Limited private debt securities market – Government main issuers of bonds – Limited sources of long term funds – Buy and hold practice by investors preventing active secondary trading 1986 1987 SOURCE: Cagamas Berhad company report 1▪ Launch of “Liquidity Model”: Purchase with Recourse (PWR) ▪ Cagamas started by purchasing housing loans from financial institutions on a “with recourse” basis ▪ Initially, only one product buying on fixed rate for 5 years with recourse ▪ Cagamas issued the first Islamic RMBS 2004 2005 2▪ Launch of “Securitization model”: Purchase without Recourse (PWOR) ▪ Due to the change in market conditions (excess liquidity in banking system and low interest rates), the banks required, in addition to liquidity tool, the creation of a risk management tool | 25 In the core of Malaysian capital market solution for mortgages lies on Cagamas Business model Products Structure Proceeds from sales “Liquidity model”: Purchase with recourse (PWR) programme Debt security Mortgage originators Purchase mortgages with recourse Cagamas Proceeds from sales “Securitization model”: Purchase without recourse (PWOR) programme RMBS Bond issuance proceeds Sell Cagamas bonds Purchase mortgages without recourse Asset warehousing Investors Sells ABS/ synthetic securitization SOURCE: “Mortgage Backed Securities Market in Malaysia” by Huang S. Chang, Cagamas Berhad company report | 26 BCCs have developed a transaction structure to issue RMBS on a frequent basis Building blocks ▪ ▪ ▪ Transaction diagram Representative of noteholders Deutsche Trustee Company Ltd Originators and services Italian Cooperative Banks Operating bank ICCREA Banca S.p.a. Collections ▪ BCCs (credit cooperative banks), the Originators of the transaction, are local banks which support the local economy – More than 400 BCCs operate in different regions of Italy (mostly in wealthier Northern regions) – BCCs can only lend to people residing or businesses operation in their area of operation Credico Finance, the issuer, is a SPV pursuant purchase monetary claims in the context of securitisation transactions and to fund such purchase Law 130 with the sole purpose of by issuing asset backed securities or by other forms of limited recourse financing The Portfolios purchased by the Issuer comprise debt obligations arising out of residential mortgage loans classified as performing by the relevant Originator In every transaction, each BCC sells a portfolio of their mortgage loans to Credico Finance (credit risk is transferred to Credico Finance), who pools the purchased mortgages and securities the portfolio. Credico Finance issues – Class A notes that are sold to investors – Class B notes that are sold to BCCs BCCs maintain the servicing on the portfolios SWAP counterparty JPMorgan securities Retained by each seller bank Purchase price ▪ Class A notes Issuer Credico Finance 9 S.r.l. Back-up services ICCREA Banca S.p.a. Class B notes Limited recourse loan provider Italian Cooperative Bank SOURCE: Credico Finance 9 S.r.L Prospectus, DBRS Credico Finance 9 S.r.L rating report | 27 Mortgage issuance is practiced on a regional level Mortgage loan Loan payments Description ▪ ▪ ▪ BCCs can only lend mortgage to people residing in their area of operation1, who make mortgage payments to respective bank’s portfolio Originator (BCC member) has its own characteristics and procedures of issuing loan, yet there are some common feautures across BCCs DBRS (rating agency) conducts operational risk review (do not rate individual originator) on large volume portfolios (44.85%) prior to securitization How it works Key implications Client A1 BCC member A Client A2 Portfolio A ▪ Although originators do not have an exhaustive underwriting criteria, common creditworthiness criteria analysis creates minimal differences in underwriting principles ▪ By reviewing underwriting procedures of banks which represent the largest proportion of the portfolio, DBRS is able to evaluate the risk in the portfolio Region A … … … … … … … … … Client D1 BCC member D Client D2 Portfolio D Region D 1 BCCs are non-profit oriented local banks, aimed at supporting families and businesses inside a defined area SOURCE: Credico Finance 9 S.r.L Prospectus, DBRS Credico Finance 9 S.r.L rating report | 28 Servicing is handled by originators and assisting banks Description ▪ Originators remain to be the servicer of the mortgage loan ▪ Originators transfer received mortgage payments to operating bank (ICCREA Banca) on a daily basis ▪ ▪ Operating bank transfer the payments from originator mortgage portfolios to an Agent Bank (Deutsche Bank) every 15 days The agent bank pays coupon payment to bondholders (market and BCCs) ▪ Unless a triggering event occur (crosscollateralization), each BCC is paid its associated Class B tranche payment ▪ Issuer employs a swap counterparty (JP Morgan) to hedge against interest rate risk How it works Key implications ▪ Allows Credico Finance to act truly as a SPV ▪ Creates liquidity and excess cash to be invested for each acting bank, until transfer of funds ▪ Originators are bound to issue good mortgages as Class B Notes will not be payed in an event of delinquency (double check) Agent bank Class A Note Payments Operating bank Issuer Class B Note Payments Originator SOURCE: Credico Finance 9 S.r.L Prospectus, DBRS Credico Finance 9 S.r.L rating report Retained by each seller bank | 29 Government support may help to kick start and sustain secondary mortgage market (1/2) Definition Repo eligibility Government guarantee Capital requirements Tax advantages Reason Examples ▪ Eligibility of CIE’s PBs with TCMB’s repurchase agreements ▪ To help bank treasuries regard PBs as liquid tools ▪ common implementation (e.g., European Central Bank and Malaysia) ▪ Government guarantee for payment delay risks of banks ▪ Increasing reliability of new product and appetite of foreign investors ▪ ▪ Cagamas bonds in Malaysia Implemented in the first stage of CRH in France ▪ 0% risk weighting in capital efficiency ratio calculations ▪ Ability to hold these bonds by bank treasuries without capital requirements ▪ ▪ 0% in Malaysia Current RWA weight is in line with Europe, however effectively disadvantageous because minimum capital efficiency ratio in Turkey is high ▪ Tax allowance /benefits for covered bond revenues ▪ Making the issuance more economic by decreasing investors’ expectations about margins ▪ VOB was supported with tax advantages in early stages | 30 Covered bond incentives may help to kick start and sustain secondary mortgage market (2/2) Tax benefits Stamp duty exemption Withholding tax reduction Required reserve ratio ▪ Turkish covered bond 10% risk weighting1 ▪ ▪ French CRH1 bonds and OF1: 10% risk weighting French OFH1 bonds: 20% risk weighting ▪ German Pfandbriefe: 10% risk weighting (fully compliant with CRD and UCITS) ▪ Italian OBG1: 20% risk weighting ▪ Cagamas:0% risk weighting in Malaysia as they are recognized as liquid assets ▪ Risk weighting depen-dant on risk weight of the issuer. Minimum 10% maximum 100% ECB purchasing program Government guarantee on covered bonds at the beginning ▪ ECB purchasing program Market making commitment by 17 institutions for Jumbo Pfandbriefe exceeding EUR 1bn in volume ▪ ECB purchasing program ▪ Government support in establishment of a sustainable market (e.g., rating agency, auction system, information system) ▪ ECB purchasing program Repo Others (e.g. ECB purchasing program) ▪ ▪ ▪ 1 CRH: Caisse de Refinancement de l’Habitat; OF: Obligations Foncières; OFH: Obligation de Financement de l’Habitat; OBG: Obbligazioni Bancarie Garantite SOURCE: Factiva, CRH 2010 Annual Report, firm’s website, European Covered Bonds Council | 31 Contents ▪ Need for a Capital Market solution for the mortgage market in Turkey – How to ensure a long term sustainable growth of the Turkish mortgage market ? – What are successful international examples ? – Is there local and/or international appetite for investing in such a market ? – Is the Turkish regulatory framework ready ? – What have been, so far, the main hurdles ? ▪ Proposed Capital Market solutions and key economics ▪ Summary of results from first meetings with key stakeholders ▪ Proposed implementation roadmap | 32 We talked to both local and international investors Implications on Capital Market solution design What they told us Local investors ▪ Overall appetite ▪ ▪ International investors SOURCE: Interviews Mortgage market is small, so currently banks can fund through shorter term financing Going forward maturity mismatch will pressurize banks Restrictions for portfolio allocation to securities other than sovereign bonds ▪ Sustainable local investor demand ▪ Competitor banks would not buy single originator bonds, multi-originators preferred Higher capital adequacy requirements ▪ None – Key requirements are more relaxed compared to other EU countries Joint-issuance through central solution ▪ None – Requirements are in line with European regulations ▪ Investment limit ▪ ▪ Competition ▪ ▪ Capital benefit ▪ ▪ Cash flow management ▪ Not repo-eligible in contrary to international benchmarks ▪ Need for government/regulatory involvement (tbd) ▪ Regulatory hurdles ▪ Delays (1 month or so) occur due to regulatory hurdles ▪ None – CMB is not the bottleneck ▪ Customer relationship ▪ Mortgage loan is an anchor product, critical for customer retention ▪ None – CMB is not the bottleneck ▪ Overall appetite ▪ Stretch price Turkey covered bond 100 bps spread over normalized İtalian or Spanish covered bond before crisis ▪ Servicing mechanism ▪ Currency risk ▪ ▪ Currency is still a concern Real money investors would be interested only if in Euro or USD denominated ▪ Additional yield to investors to cover currency swap | 33 Overall appetite – In the short/medium term, investments will mainly driven by bank and corporate treasuries Billion Euro Local investor type Asset under management Description ▪ Real money managers 48 ▪ ▪ Funds established by private pension and life insurance companies Collected funds are ready to be invested to long-term instruments UK example Money market Stock exchange 34 UK covered bonds Fixed income 0.7 - 1.0 Other 62 Money market 10 Stock exchange 6 Potential target size by 2020 Asset breakdown 18 19 12 UK covered bonds 35 55 Fixed income 0.1 - 0.3 Other ▪ P&C insurance ▪ ▪ Banks Institutions 2010 A&B type liquid funds established by bonds and intermediary companies Mutual funds Life insurance and pension funds 20201 Corporate treasures ▪ Total assets insurance companies providing products apart from life (e.g., fire, motor, agriculture, etc.) P&C insurance companies manage their own assets Bank treasuries investing in different investment instruments to both actualize returns, match asset/liability maturity and balance capital adequacy ratio Corporate treasuries investing in different investment instruments to actualize return 9 2 Asset under management (invested in local fixed income instruments) Money market Stock exchange 8 22 70 Covered bonds Fixed income Current private fixed income breakdown 0.1 - 0.2 Other Potential covered bond breakdown 153 Other bonds 34 2010 14 – 15 62 38 Private Other bonds Covered bonds2 2020 Bank and corporate treasuries have the highest Total potential potential to invest if they decide to increase bond 16% sharefor in their total investments 1 Growth forecasts (19% CAGR for pension funds&insurance funds, 15% CAGR for mutual funds iscovered estimated, institutional treasuries) by 2020 2 Covered bond is assumed to have 25% of all private bonds held by institutions SOURCE: GBP, CMB, Undersecreteriat of treasury | 34 15 – 16.5 Investment limit – In terms of regulatory constraints on investments, Turkey is even more relaxed compared to other European countries Investment limits of institutional investors on covered bonds Percent of total AuM Key findings 55 Mutual funds ▪ 25 25 ▪ 20 Pension funds ▪ 7,5 N/A SOURCE: Regulations There are specific legislations in Germany and Sweden limiting mutual funds’ investments on covered bond market For pension funds, Germany Pensionskassens have a 7,5% limit for ABS/CLN investments, whereas Sweden does not have any as long as covered bond risk matches the sovereign bond risk Turkey has no specific regulation for covered bond investments as it is not a welldeveloped instrument in Turkey and no rigid regulatory constraint is present from investment side | 35 Capital benefit – Risk weighting of cover bonds in Turkey is aligned to Basel framework, but the minimum capital adequacy ratio is higher Comparison of risk weights of sample assets used in capital adequacy calculation in Turkey and Basel II Percent Risk weighted assets Turkey Basel II Assessment & conclusions Cash Government bond Covered bond (MBS) 0% 0% 0% 0%4 Minimum capital adequacy ratios 1 Target ratio by BDDK, regulation enforces 8% 2 Will gradually rise to 10.5% by 2019 3 35% for LTV up to 80% 35-50%3 50% 12%1 Covered bond treatment in terms of RWA calculation for local investors is less strict than the international peers, as Basel II has not yet been implemented in Turkey (CB risk weight can go up to 100% depending on the ratings) ▪ On the other end, minimum capital adequacy ratio (CAR) is more strict in Turkish regulations compared to Basel II 10%5 10% Mortgage loan ▪ 8%2 4 Depends on country rating, may go up to 150% if rated below B5 Depends on covered bond and Bank rating SOURCE: BDDK, “Bankaların Sermaye Yeterliliğinin Ölçülmesine ve Değerlendirilmesine İlişkin Yönetmeliği”, Basel II, CRD, European Central Bank | 36 Competition between banks could prevent some treasuries from investing directly to each others’ securities “In the current competitive environment, a bank would never buy its competitors’ securities” Head of treasury of a bank Potential mitigations “Investing other’s securities would increase their ratings, why should we do that?” ▪ Multi-originator system similar to Italy (BCC), France (CRH), Mexico (Hito), etc. would eliminate competition concerns Head of treasury of a bank We can invest in covered bonds issued by other banks. We currently invest in other corporate bonds as well Head of treasury of a bank SOURCE: Interviews, CMB | 37 Data requirements from Turkish regulatory body is slightly more relaxed compared to international benchmarks Dimension Issuer information and contact details Programme details Asset pool details and management Requirements ▪ ▪ ▪ ▪ ▪ ▪ ▪ Outline of the structure of the programme Outline of 3rd party contractual agreements Contingency plans in case of 3rd party default ▪ ▪ ▪ Details of eligibility and replacement criteria Asset pool management details Scheme of internal processes (e.g. asset segregation, cash flows, replacement plans, etc.) Stress tests on the asset pool and issuer ▪ ▪ ▪ Documents Contact details of issuer Credit ratings issuer Proof of eligibility of the issuer Organization chart and financial reports for last 5 years ▪ ▪ ▪ ▪ ▪ Credit rating reports Prospectus and circular (if not private placement) Cover monitor/external reports on the pool Internal audit report Organization chart of asset pool management Copy of documents related to stress testing Copy of 2 most recent reports on covered bond transactions SOURCE: CMB, interviews, regulatory bodies MBS VTMK Covered bonds ▪ ▪ ▪ ▪ ▪ Apart from a couple of mismatches, Turkish regulation is mostly aligned in terms of workload on issuer side – UK regulatory requirements are even tougher In Şekerbank VTMK issuance process, most of the documentation was required after the approval of application to speed up the process In line with VTMK issuance experience, current MBS legislation is expected to be relaxed requiring all documentation after CMB approval (private placement) In case of public issuance, all documents (additionally prospectus & circular) before registration and CMB evaluation will take longer In case of tap issuance, only cover monitor report and registration document is required by CMB 10 days before issuance | 38 Currency risk of TRL is a key consideration of international investors, which can be addressed by cross-currency swaps International investors are not willing to take TRL risk Swap market is growing in Turkey… Billion TL 432 447 334 “Currency is still a concern for us” 118 208 17 Global investment bank “TRL denominated bonds are only for local investors” Global investment bank 1 Extrapolated for last 3 months SOURCE: Interviews, CMB 2006 2007 2008 2009 2010 20111 … although cross-currency swap yet to gain foothold ▪ For standard Percent currency swaps Cross-currency swap with 3, 5 or 10 3 years maturity, there exists a liquid market ▪ Impact on 97 overall product Other profitability to be assessed | 39 Contents ▪ Need for a Capital Market solution for the mortgage market in Turkey – How to ensure a long term sustainable growth of the Turkish mortgage market ? – What are successful international examples ? – Is there local and/or international appetite for investing in such a market ? – Is the Turkish regulatory framework ready ? – What have been, so far, the main hurdles ? ▪ Proposed Capital Market solutions and key economics ▪ Summary of results from first meetings with key stakeholders ▪ Proposed implementation roadmap | 40 Is the Turkish regulatory framework ready ? Primary market Secondary market Capital market law No: 2499 MBS Covered bond law (Serial: III, No: 33) Mortgage Law No: 5582 ▪ ▪ ▪ ▪ Flexible interest rate options Prepayment option Appraisal Delinquency Offers sufficient framework for issuance Offers a safe investment environment for investors Compliant with EU standards ▪ ▪ ▪ RMBS RMBS Law (Serial III, No: 34) ▪ ▪ ▪ Bankruptcy and Foreclosure Code of Execution and Bankruptcy (No: 2004) Sets clear guidelines for issuing mortgage backed securities through SPVs Executes true sale and transfer of collateral under borrower consent Information disclosure methods are clearly described Borrower rights Consumer Protection law (No: 4077) ▪ Amendments pursuant to 5582 aim to kick start mortgage origination ▪ ▪ ▪ Turkey’s legal framework is mostly inline with that of our European counterparts For asset and liability management, minimum over-collateralization of 2% is lower than most peers and Turkey’s 2 week grace period practice is not common among our benchmarks Risk weighting rules are less stringent in terms of risk weight treatment of covered bonds | 41 PRIMARY MARKET Amendments pursuant to 5582 aim to kick start mortgage origination Areas of change Code of execution and bankruptcy law (No: 2004) Consumer protection law (No: 4077) Tax changes (No: 5582) Implications Right to initiate execution proceedings parallel to foreclosure proceeding given borrower’s default Creditor may also choose to execute or foreclose ▪ Originator concerns due to lengthy foreclosure and execution processes are addressed by simplifying and shortening the process ▪ Use of professional appraisers, licensed by CMB, during foreclosure process ▪ Variability in appraisals are addressed by streamlining the process ▪ Stringent liabilities to borrowers trying to delay the process (penalties1 for ungrounded claims to delay foreclosure proceedings) ▪ Shorter proceeding time ▪ Flexible payment plans for consumers ▪ Borrowers can choose between fixed or floating rate2 loan payments, with imposition of a 2% prepayment penalty for fixed rate loans ▪ Introducing grace period for consumers ▪ Acceleration right can only be exercised if borrower defaults on his payment obligations for 2 consecutive times (1 month grace period) ▪ Defining the liability of the borrower ▪ Originators are given a buffer as borrower is liable for the amount of the loan, not the value of the collateral ▪ Introduction of tax exemptions while originating mortgages and transferring them to cover pool MBS payments and issuer profits are subject to income tax ▪ House ownership is encouraged by exempting stamp, KDV and registry taxes in mortgage origination Mortgage payments are not income-tax deductable as in other countries ▪ ▪ ▪ ▪ 1 Between 10-30% penalty 2 With a cap on maximum mortgage rate SOURCE: Gide Lourette Mortgage Law report, TBB, TBMM, “Mortgage System and Contracts” by Murat Aydoğdu | 42 SECONDARY MARKET Turkish legal framework satisfies key requirements on covered bond issuance (1/2) Typical questions 1 Structure of the issuer 2 Cover assets Key considerations Who is issuer? Who owns assets? Where to recourse? ▪ ▪ Type of assets are included in cover pools What is the geographical scope of mortgage assets? What is the LTV limit? ▪ How is market risk (e.g., interest rate, currency risks) mitigated? How is liquidity risk mitigated? What is the minimum over-collateralization? How are breaches addressed? ▪ ▪ ▪ Asset and liability management Partially not aligned with international standards ▪ ▪ ▪ ▪ 3 Alignment with international standards ▪ ▪ ▪ Aligned with international standards ▪ ▪ ▪ ▪ ▪ Universal and special credit institutions can issue covered bond with recourse Issuer does not have to be the originator of the mortgage, which allows a multi-originating platform Mortgage loans originated in Turkey and substitute assets are allowed as cover assets which creates a simple and safe instrument LTV cap is inline with best practices Market risk (interest rate, currency) is hedged with derivatives, as assets and liabilities need not be matching Liquidity risk is addressed by matching bond payments and mortgage receivables Minimum over-collateralization of 2% is lower than most peers which is detrimental for bond security Breaches are given 2 week grace period in Turkey 1 Senior RMBS can be included in cover pool in other countries SOURCE: ECBC, CMB | 43 SECONDARY MARKET Turkish legal framework satisfies key requirements on covered bond issuance (2/2) Typical questions 4 ▪ Cover monitor and banking supervision 5 ▪ ▪ Segregation of assets and bankruptcy remoteness 6 ▪ ▪ ▪ Risk weighting and compliance with European legislation SOURCE: ECBC, CMB Alignment with international standards Aligned with international standards Partially not aligned with international standards Key considerations Is there an independent cover monitor? What are his duties? What is the role of banking supervision regarding covered bond (including in crisis situations)? ▪ ▪ Need for certified auditor/monitor BDDK’s role as a supervising body is clearly stated and inline with international models. Yet responsibilities of governing body in-crisis situations must be clearly defined to address investors’ concerns What is the legal framework in case of issuer’s bankruptcy? What is the cover pool? How are bond holders protected? ▪ Specific legal framework superseding the general insolvency law is in place similar to peers Only assets registered in the cover register (not total assets) are protected for investor which is optimal for issuers Receivables of debt holders of MBS are ranked more senior than government receivables Is the current system compliant with UCITS and CRD? ▪ ▪ ▪ ▪ MBS comply with the requirements of UCITS Directive as well as with those of the Capital Requirements Directive (CRD), therefore, they may qualify for a beneficial treatment under the CRD Covered bond treatment in terms of RWA calculation for local investors is less strict than the international peers, as Basel II has not yet been implemented in Turkey | 44 Contents ▪ Need for a Capital Market solution for the mortgage market in Turkey – How to ensure a long term sustainable growth of the Turkish mortgage market ? – What are successful international examples ? – Is there local and/or international appetite for investing in such a market ? – Is the Turkish regulatory framework ready ? – What have been, so far, the main hurdles ? ▪ Proposed Capital Market solutions and key economics ▪ Summary of results from first meetings with key stakeholders ▪ Proposed implementation roadmap | 45 What have been so far the main hurdles? Main hurdles So far, in Turkey we had only a single comparable deal 1 No real need of additional funding ▪ Mortgage loan funding with Data availability on originated mortgages ▪ Data supply difficulty due to Time lag between origination and securitization ▪ Long process due to internal Sufficient scale to cover originator costs ▪ No scale justification to the existing sources so far Şekerbank VTMK issuance ▪ World’s first SME loan-backed ▪ ▪ ▪ ▪ covered bonds Significantly longer than similar transactions in EU Mainly internal processes and investor alignment took longer than normally expected Significant time spent with rating agencies to finalize ratings IT system development has been quite efficient 2 3 4 Already discussed in the initial sections nonstandard underwriting practices inefficiencies and external negotiations with investors Detailed in the following issuance cost, esp. for smaller banks | 46 Şekerbank SME-loan backed covered bond issuance was the first example of individual issuance in Turkey which took significantly longer than similar transactions in EU Average issuance time1 Days Key reasons for longer process ~600 ~100 ▪ Learning curve of Şekerbank – Determining eligibility criteria for cover pool – Developing IT infrastructure – Creating first documentation ▪ First SME-loan backed covered bond in the world – Moody’s spent significant time to determine rating procedure – Investors made repeated analyses to understand the product and their internal evaluation and approval process took significant time 1 Time between first decision until issuance SOURCE: Interviews, press search | 47 Mainly internal processes and investor alignment took longer than normally expected Preparation (~8 months) 2009 11 Cover pool creation (~4 months) Execution (~8 months) 2011 2010 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 Şekerbank ExCo decision Determining eligibility criteria Rating process IT system development Cover monitor initial audit Documentation preparation Deal review by investors Cover pool update CMB evaluation Final documentation to CMB ~8 months Start of initial preparation ▪ ▪ ▪ ▪ SOURCE: Şekerbank interview ~8 months End of initial Official CMB preparation application Cover pool eligibility criteria is determined with investors (IFC, FMO and Unicredit) and Moody’s IT system development for systematic cover pool creation and to demonstrate cash flow segregation and no co-mingling Internal term sheet preparation and informing CMB Contacting BDDK for its advice ▪ ▪ ▪ ▪ Initial cover pool selection Documentation preparation with Unicredit Legal services from White&Case and Verdi&Yazıcı Initial report from cover monitor (Ernst&Young) ▪ ▪ ▪ ▪ ~8 months Covered bond issuance Review and fine-tuning of agreement/cover pool by investors Quarterly documentation update Final documentation sent to CMB 5 days before the issuance and registration (ISIN generation, registration at MKK) Swap mechanisms by investors (3-5 days) | 48 2 Available Data availability – Survey results indicate that not all the banks are ready to meet the necessary IT infrastructure/database to issue a covered bond Partially available Not available Evidence demonstrating some banks are not ready to answer some typical questions regarding eligibility Select Questions Bank 1 Bank 2 Bank 3 Bank 4 Bank 5 In our data survey, we asked data on portfolio characteristics, of which most are included in eligibility criteria ▪ We compared which banks responded clearly to these questions and which could not Payment schedules Probability of default Loss given default Borrower characteristics ▪ Property characteristics Approach Loan characteristics Average LTV ratio of current portfolio Average value of collateral Location of mortgages Debt-to-income ratio Annual income These two banks would have difficulty in preparing an eligible covered pool and get rating before a comprehensive IT restructuring SOURCE: Survey results | 49 3 Complexity – Effective solutions should be designed to remove risks associated with time-lag between origination and securitization Detailed next Key concern regarding complexity ▪ ▪ ▪ Longer time between origination and securitization puts market risk on the shoulders of originators Market risk is due to the changing market conditions at the time of origination and securitization Activities between origination and securitization has a considerable impact on originators’ resources Possible solution Description ▪ “Tap issuance” ▪ “Well-defined SLAs” ▪ ▪ Originators may issue RMBS/covered bonds with a streamlined process based on past issuances at the original face value, maturity and coupon rates Hence, some process steps can be eliminated resulting in faster execution Defining internal SLAs regarding application preparation Defining SLAs for CMB to process application faster by removing some unnecessary, if any, steps Both of these initiatives will require significant standardization | 50 Complexity – Tap issuance is a widely used method to eliminate some of the fixed cost items 3 Description ▪ ▪ ▪ Originators may sell RMBS/covered bonds based on part issues, at the original face value, maturity, and coupon rate ▪ Percentage of covered bond supply through tap issuance in 2011 YTD1 France Spain Fewer fixed cost items incurred by eliminating Germany – Certain legal cost – Some transactions costs such as prospectus issuance New SPV establishment for RMBS issuance Extremely useful in case of small issuances 21% UK Pricing is based on the current market conditions at the time of new issuance – ▪ International examples 19% Implication for Turkey 15% ▪ Italy ▪ 9% 7% Sample issuances of mortgage-backed covered bonds in France ISIN Date Issuer FR0011071299 FR0011035229 FR0011053123 FR0011075969 FR0011093541 FR0011099506 FR0011129006 FR0011131861 FR0011136068 21.Haz.11 08.Nis.11 30.May.11 01.Tem.11 09.Ağu.11 17.Ağu.11 30.Eyl.11 07.Eki.11 19.Eki.11 Credit Mutuel Arkea Home Loan SFH Credit Mutuel Arkea Covered Bonds SA Credit Mutuel Arkea Home Loan SFH Compagnie de Financement Foncier - CFF Compagnie de Financement Foncier - CFF Compagnie de Financement Foncier - CFF Compagnie de Financement Foncier - CFF CIF Euromortgage Compagnie de Financement Foncier - CFF Face value Euro 16.000.000 € 16.000.000 € 10.000.000 € 24.500.000 € 10.000.000 € 15.000.000 € 20.000.000 € 8.000.000 € 10.000.000 € Program amount Euro 10.000.000.000 € 10.000.000.000 € 10.000.000.000 € 125.000.000.000 € 125.000.000.000 € 125.000.000.000 € 125.000.000.000 € 30.000.000.000 € 125.000.000.000 € Current regulation enables for originator use tap issuance – Bylaw on principles regarding MBS, serial III, No. 33, article 26-4 – Bylaw on principles regarding Konut Finansmanı form and RMBS, serial III, No. 34, article 17 1 Tap issuance is almost conducted in each issuance in Denmark and Sweden SOURCE: Danish Mortgage Bank Association; Investopedia; Dealogic; Financial Times | 51 4 Scale – Creating scale in capital market solution issuance is critical for achieving lower fixed cost per size while enabling market liquidity Key concerns Fixed costs Proposed solutions ▪ ▪ Market liquidity ▪ ▪ Securitization process incurs significant fixed costs such as application procedures, HR needs, SPV establishment for RMBS, etc. Since these costs does not change depending on the size of issuance, it is more desirable for originators to pool more mortgage loans together Tap issuance Multioriginator system Higher scale of issuances ensures liquidity of the market because investors can buy/sell the CBs/RMBS early from/to investors owning products of same issuance This increases attractiveness of product hence making it possible for originators to easier manage their spreads Standardization ▪ Originators may sell RMBS/covered bonds based on past issues ▪ Fewer fixed cost items for each tap issuance ▪ RMBS/covered bond issuances may be based on the mortgage loans from multi-originators ▪ Fixed costs can be shared by a number of originators ▪ Positive impact on market liquidity ▪ Uniform bonds/securities of identical coupon, maturity, type of amortization make it easier to create scale of pools while reducing operational costs (e.g. documentation, rating processes, etc. ) | 52 4 Scale – Fixed costs of securitization process are diluted in total costs with increasing scale Methodology ▪ ▪ Included cost items – Placement fee – Underwriter counsel – Trustee counsel – Rating – Listing – Marketing – Loan audit – Modelling time-out Return per issuance volume Return of bank Bps 384 300 Breakeven return 250 25 0 35 100 Issuance volume Million TL Breakdown analysis is based on – Realized return of bank – Volume issued in an issuance -445 ▪ ▪ Breakeven return is calculated assuming banks would at least get 20% IRR over their servicing expenditure As issuance volume increases, return of the bank increases as well | 53 4 Scale – Multi-originator systems are widely used in the world and as they can help to achieve effective scale for issuance Capital market solution Country ▪ Covered bond ▪ Operating model CRH (owned by French Banks) ▪ ▪ CRH gives loans to Banks, which propose mortgage loans as collateral, with a minimum 25% overcollateralization CRH issue bonds in the market and cash flows from the CRH loans to Banks perfectly match the issued bonds Spain “Cedulas TDA” ▪ Covered bond ▪ TDA (owned by private banks and JP Morgan) ▪ TDA collects covered bonds from individual banks and realize joint-issuance of covered bonds which are bought by investors Malaysia “Cagamas” ▪ ▪ RMBS Covered bond ▪ Cagamas (owned by Central Bank and private banks) ▪ Cagamas purchase mortgage loans either with recourse (debt securities) or without recourse (RMBS) from different originators and sells securities to investors Mexico “Hito” ▪ RMBS ▪ HiTo ▪ (owned by governmental ▪ bodies and private companies HiTo is an organizer that conducts RMBS auctions periodically Small-sized mortgage banks can have joint-issuance to address scale problems Italy “BCC” ▪ RMBS ▪ Credico Finance Local Banks (BCC) sell a portfolio of their mortgage loans to Credico Finance, transferring also credit risk Portfolios are pooled and securitized RMBS Hybrid Covered bond France “CRH” Central unit (Platform) ▪ ▪ SOURCE: CRH, SHF, HiTo, Cagamas Berhad company report, Cagamas Berhad 2010 annual report, LatinFinance, Credico Finance 9 S.r.L Prospectus, DBRS Credico Finance 9 S.r.L rating report | 54 4 Scale – Standardization enables achieving higher scale of issuances while making it easier to pool mortgage loans Standard loan products Benefits of standardization ▪ Supply of loan product is standardized ▪ Supply of large quantities of uniform capital market products ensures market liquidity ▪ Borrower has a limited option of loans with predetermined ▪ It is easier to pool uniform capital market products, hence it is possible to reduce some of operational steps/costs – Loan type – Term – Currency – Amortization profile In Denmark, fixed rate mortgage loans can have only 20 or 30 year duration SOURCE: Danish Mortgage Bank Association ▪ ▪ Easier to conduct tap issuance Standard bonds/securities ▪ Uniform covered bonds or RMBS with identical – Coupon rate – Maturity – Amortization profile Easier to pool mortgage loans from multioriginators Covered bonds perfectly match associated loans, hence fixed rate bonds can also only have 20 or 30 years maturity | 55 Contents ▪ Need for a Capital Market solution for the mortgage market in Turkey ▪ Proposed Capital Market solutions and key economics ▪ Summary of results from first meetings with key stakeholders ▪ Proposed implementation roadmap | 56 Proposed Capital Market solutions – key messages ▪ ▪ ▪ ▪ ▪ ▪ ▪ ▪ Due to recent global crisis, covered bond is considered the most suitable solution in the short-term, as it keeps the credit risk with the originators unlike RMBS Current legislation enables the issuance of covered bonds, however there is a need for more organized and standardized approach to start-up the secondary mortgage market While every bank can, already today, issue covered bonds, to enable the organized and standardized approach, a central issuing entity (CIE) is proposed as a complementary solution In particular, CIE will be owned by Turkish banks willing to participate in secondary mortgage market Each individual bank will issue covered bonds which will bought by CIE and programme bonds will be issued backed by covered bonds from different banks This will ensure standardization and faster overcoming of learning curve, while providing large-scale market CIE will also enable the option of individual issuance through it, hence operational benefits of central solution will also be enjoyed by individual issuances Both individual and central solutions are economically justified, however central solution with more strict standards and additional utilities such as liquidity facility will receive better rating and higher spread for originator banks | 57 Two possible non-conflicting methods are available in Turkey for implementation of capital market solutions “Individual” solution Two non-conflicting methods in implementation of capital market solutions Investor (CIE) “Systematic” solution ▪ ▪ CIE is a pass through lean organization with low fixed costs Both individual needs of large banks and multi-originator issuance of small banks (in order to solve volume hurdles) can be implemented via CIE | 58 “Individual” solution – The main challenges will be to overcome learning curve and ensure standardization Key learnings for individual MBS issuance Description 1 IT system/data quality 2 Already today banks can issue their own covered bond programs Process 3 Documentation 4 ▪ ▪ ▪ ▪ ▪ ▪ CMB SOURCE: Interviews ▪ Internal and investor-related processes still not welldefined First issuance mostly through bootstrapping and navigating the processes The main challenges for starting individual covered bond issuance will be – Data integrity – Standardization ▪ After the first attempts, learning curve might be overcome, but only in case of similar deals ▪ Hence, complexity of individual issuances will continue unless agreed upon common standards Documentation initially may take a lot of time mainly due to uncertainties of rating agencies and investors Streamlining internal processes, such as approvals, may reduce required efforts for documentation ▪ Lack of standardization might require a very long review period by investors, and postpone their decisions ▪ CMB acts very quick and cooperative, hence external/regulatory-related processes are not the bottleneck Investors 5 Developing necessary IT solutions (e.g. queries, database clean-ups) will be very quick as long as integrity and validity of data is ensured In case underwriting practices are not aligned to rating agencies’ expectations, one-to-one negotiations and reviewing of end-to-end processes will take longer | 59 “System” solution has significant advantages over individual issuances Key benefits Rationale ▪ Reduced complexity ▪ ▪ ▪ ▪ Standardization of issuance processes and covered bonds No investor relation and road show effort on bank side No individual rating hassle for banks Centralized interaction with CMB through CIE ▪ Specialization ▪ ▪ Central guidance for banks through their internal processes Share of know-how among banks ▪ Streamlined approach ▪ Single touch point with the government solely focusing on MBS market Representation of all banks together before regulations Banks ▪ ▪ More market liquidity ▪ Frequent and large scale issuances through streamlined processes and aggregation ▪ Broader local investor base ▪ Easier access and evaluation of standardized covered bond by local investors Resolution for competition concerns of large banks Investors ▪ ▪ Higher market confidence ▪ Clear guidelines & eligibility criteria leading to higher confidence to products | 60 Why we might need CIE 1 Investor appetite 2 ▪ Program bonds issued by CIE chould be more attractive both to local investors (no “competition effect”) and to informational investors (more standardized/transparent/reliable underlying) ▪ CIE would allow banks to get additional funding and diversify funding sources (to cover liquidity needs) in a faster and more efficient way ▪ CIE should provide efficient and effective servicing to those banks willing to issue their own covered bonds ▪ CIE would require banks to provide liquidity/market making (thus creating, possibly, a new source of business) ▪ CIE could enable a much healthier development of the mortgage market (i.e., standardization, transparency, ...) Quick funding 3 Serving/ outsourcing 4 New business 5 Healthy market | 61 Individual Turkish banks have comparable ratings Issuer default risk Long term rating SOURCE: Bloomberg, Moody’s Senior unsecured rating Ba3 Ba1 Ba3 N/A N/A Ba1 Ba3 Ba1 Ba3 Ba1 Ba3 N/A Ba3 N/A Ba3 Ba1 Ba3 N/A | 62 Two different structures can be used in establishing a central entity for covered bond and RMBS issuance of banks Current legal infrastructure ▪ ▪ House Finance Fund ▪ ▪ ▪ ▪ ▪ Covered bond issuance process RMBS issuance process ▪ Regulated by CMB law, clause no: 38/B No legal entity requirement and no obligations for capital (CMB Communiqué, Serial 111 No:34, Article 4) Can be established by banks, financing companies and mortgage finance institutions (CMB Communiqué, Article 3, 5) Founder must launch a new fund and assign a fund committee (composed of 3 participants) before every issuance (CMB Communiqué, Article 6) Bank covered bonds take place in House finance Fund’s portfolio and RMBS is issued (CMB Communiqué, Article 20b) Regulated by CMB law, clause no: 39/A Related CMB Communiqué is still in production Its structure should be an incorporation with capital at least as much as1 development and investment banks Covered bonds purchased from banks ▪ Mortgage receivables are transferred to cannot be used as a collateral for another Mortgage Finance Institution and registered to General Directorate of land covered bond due to : registry – Bank covered bonds are not regarded as substitute assets according to ▪ Mortgage Finance Institution launches Article 10 of current CMB Communiqué a House Finance Fund for RMBS issuance (according to amendment in (Serial 111, No: 33) CMB Law draft Article 58.9, Mortgage – Substitute assets form max. 15% of Financial Institution may issue RMBS total cover pool separately (CMB directly) Law, Article 13/A – not available in CMB Law draft – Communiqué 33, Article 18) Minimum capital needed is same as Fund procurement to banks can be done bank/investment enterprise capital only if housing finance receivables and need other assets are provided as guarantee (min. TL 20 million) and covered bonds can be issued over these guarantees (CMB Law, Article 39/A; CMB Law draft, Article 60-4) TOKİ’s non-collateralized real estate receivables ▪ Mortgage Finance Institution ▪ ▪ ▪ Collateralized receivables are transfered to fund portfolio(CMB Communiqué, Article 20a) Collateralized receivables are registered to General directorate of land registry on behalf of founder Limited capital requirement can not be used for MBS and RMBS issuance without an additional regulation 1 TL 20 million SOURCE: CMB | 63 Tax liabilities may differ based on the status of new CIE and they of issuance: covered bond or RMBS Tax types Stakeholder Corporate tax CB: Should be assessed like a bond; interests and valuation costs should be reported as expenditures RMBS: 20% ratio is valid in case of profit ▪ Used only in case of getting commission for brokerage ▪ ▪ Exception ▪ – ▪ – ▪ 0%: foreign companies and funds similar to Turkish companies and funds 10%: Real person investors ▪ 0%: Banks, Turkish mutual funds and pension funds 10%: Real person investors ▪ ▪ Bank Central Entitiy ▪ Mortgage finance institution House finance fund ▪ Limited taxpayer investors Investors Withdrawal – – ▪ ▪ ▪ ▪ Fully amenable investors ▪ ▪ ▪ ▪ – Banking and Insurance Transaction Tax/Value Added Tax CB: No BITT because balance in favor is zero RMBS: If balance in favor, exception1 must be implemented Exception in scope of house financing Should not be implemented because balance in favor is zero2 Stamp tax (Revenue stamp) ▪ ▪ CB: Exception RMBS: Exception if within the scope of house financing ▪ 0.005% over current net value of security assets Exception ▪ Exception ▪ Exception ▪ Exception ▪ – ▪ – ▪ – ▪ – – For banks: – 5% BITT for interest revenues – 1% BITT for capital income Exceptional implementation for pension funds and mutual funds There shouldn’t be VAT ▪ ▪ ▪ ▪ ▪ Exception CMB registration fee Fees Does not occur if investment is not under the coverage of stamp tax3 (in case it is %0.825) 1 Controversial. Treasury may claim BITT implementation 2 Controversial. Revenues from CB or mortgage loans and interest paid for RMBS are two different transactions thus can be regarded as BIT 3 Effective when one of the signors is a fully amenable investor, not applicable when none of the parties is a fully amenable investor | 64 Building blocks of proposed solution Building block 1 Programme Description ▪ ▪ ▪ 2 “Issuer” 3 Cover pool 4 Form of Programme Bond 5 Liquidity facility Detailed in the next pages CIE establishes a “programme” to refinance TL denominated Covered Bonds issued by CIE shareholders (“CB”) through the issuance of TL denominated programme bonds (“PB”) Each Originator Bank issues CB in series, made of same coupon, payment date and maturity Each CBs of a specific series are associated to a correspondent PB issued by CIE ▪ ▪ ▪ “Central issuing entity” (“CIE”) is a master trust with limited liability Equity of CIE is owned by main Turkish banks but CIE is independent from shareholders banks CIE is managed by a special purpose management company with limited liability and under the supervision of CMB ▪ Cover pools are made of residential housing loans compliant to eligibility criteria, e.g., type of loans, maximum amount, maximum residual terms Collateral of PBs are CB issued by Originators Banks ▪ ▪ ▪ ▪ The programme issues fixed-rate PB (floating-rate bonds to be discussed) Type of amortization of PB is bullet (amortizing bonds to be discussed) The liquidity facility must be sufficient to cover the interest payments on PBs for at least [••] year(s) in case of default of CBs issuer ▪ Priority of payments is sequential 7 Trigger events ▪ ▪ The programme is cancelled and CIE liquidated in case “termination trigger” happens CB issuers are responsible for setting up a cash deposit if OC falls below [•]% (“OC trigger”) 8 Servicing ▪ ▪ Servicing activity will be carried out by the originating banks CIE appoint a Turkish entity as backup servicer to step-in in case a “servicer event” occurs (e.g., the servicer fails to provide monthly report) 9 Cover monitoring ▪ CIE is appointed of the supervision of the Originator Banks’ obligations in respect of the cover pool ▪ Fitch's rating approach to multi-issuer covered bonds is based on (i) strength of the Originators Banks, (ii) quality of the Cover Pools, (iii) obligor Concentration and (iv) default probability of the rated notes Existence of “country ceiling” to be further investigated 6 Waterfall of payments 10 Rating ▪ | 65 1 Merkezi İhraç Kurumu (CIE) bankalar ve piyasa arasında bir servis sağlayıcı ve aracı olacaktır Katılımcı banka 1 “Merkezi İhraç Kurumu - CIE” OC Teminat varlıkları İpotekli tahvil Banka 1 Katılımcı banka 2 Diğer varlıklar Öz sermaye İpotekli tahvil Banka 1 Merkezi ihraç kurumu (CIE) program tahvilleri (PB) seri I İpotekli tahvil Banka 2 CIE PB seri II CIE PB seri III İpotekli tahvil Banka 2 Diğer kurumlar OC Teminat varlıkları CIE, teminat havuzunu ve ihraç standartlarını belirler (örn: derecelendirme kuruluşlarıyla uygunluk kriterlerini belirlemek) ▪ Bankalar mortgage’a dayalı ipotekli tahviller ihraç eder ▪ CIE bu ipotekli tahvilleri kendi program tahvillerine (PB) teminat olarak satın alır ▪ CIE, katılımcı bankaların mülkiyetindeki yalın bir organizasyondur Yatırımcılar Seri ihracı CIE PBleri İpotekli tahvil … OC Teminat varlıkları ▪ İpotekli tahvil Likidite kuruluşu | 66 1 Preliminary investigations demonstrate that CIE could work both for “Programme Bonds” and “CIE RMBS” Approach ▪ “Programme Bonds” and “CIE RMBS” can be issued by 2 dedicated “house finance fund” in order to “segregate” the different underlying asset pools ▪ Issuance can be executed by a “Central Issuing Platform” ▪ Management company for both funds could be the same Potential structure of “Central Issuing Entity” (CIE) Central Issuing Entity (CIE) Central Issuing Entity for Programme Bonds CIE management company Key points to be investigated on “CIE RMBS” origination In RMBS, assets are transferred by banks to CIE as “true sale” transactions. This implies that CIE: ▪ Assume direct risk on mortgage assets with no recourse to selling bank ▪ Gets ownership of the mortgage and therefore is responsible for servicing them (but this could be delegated to bank themselves) ▪ Has to provide hedging for interest rate and currency Central Issuing Entity for RMBS Finance Funds | 67 1 Diagram of cash-flows of the solution ▪ No possible mismatch within CIE ▪ structure because the fix/floating-rate PB are collateralized by a set of fix/floating CBs that pays same amount on the same date with same amortization scheduling ▪ CIE will be able also to draw on a liquidity facility to meet any interest payment shortfalls on PB in the event of a single CB’s default ▪ Possible mismatch between: – Cash inflows from mortgages and cash outflows to CIE – Interest rates as the features of the coupon of single CB could be completely independent from interest rate of cover pool ▪ If significant, the cash-flows mismatch must be managed by each Issuer trough ALM, as already done by French banks participating to CRH program or Spanish banks participating to Multi-Cedulas program Interest on PB Interest on CBs Principal on PB Principal on CBs Investors CB 1 Cover pool 1 CB 2 Cover pool 2 Interest rate on mortgages CIE Proceeds Programme Bond Proceeds CB n Cover pool n Single bank Covered Bond | 68 1 Example of a program structure Key elements Description ▪ CIE establishes a “programme” to refinance TL denominated Covered Bonds issued by CIE shareholders (“CB”) through the issuance of TL denominated PBs The programme could include the participation of any of the shareholders financial institutions ▪ ▪ Programme size is up to [•] billion of TL outstanding Programme limit may be increased in accordance to shareholders agreement ▪ Each Originator Banks issues CB in series; series are made of residential mortgages with same coupon, payment date and maturity Each CBs of a specific series are associated to correspondent PBs of the series, issued by CIE (CIE, as master trust, allows to sell multiple series of PBs from the same trust) PBs of each series are collateralized by all CBs of the series: additional CBs are fungible with the existing ones In case of tap issuance on existing series: – Originator Banks tap issue CBs; as a consequence – CIE issues PBs of same series for an amount equal to tap issuance In case of issuance of new series: – Originator Banks issue CBs; as a consequence – CIE issues PBs of new series for an amount equal to new issuance ▪ Description Programme size ▪ ▪ Issuance in series ▪ ▪ Maturity date Issue price ▪ ▪ The programme will end on Dec 31, [•] The maturity of each series will be up to [•] years ▪ Covered Bonds will be issued on a fully-paid basis | 69 2 Issuer – “Central Issuing Entity” Description ▪ Central Issuing Entity (CIE) is a “passthrough” master trust with limited liability, specifically established according to the laws of Turkey ▪ Equity of CIE is owned by main Turkish banks, but CIE is independent from them (bankruptcy proceedings or liquidations of banks, holding CIE equity, cannot be extended to CIE) ▪ CIE will be structurally similar to “Konut Finansmanı Fonu”, however with possible exceptions to its role, activities, and issuances ▪ CIE does not borrow for its own account but on behalf of banks and does not charge any interest on its refinancing activities ▪ CIE will be managed by a special purpose management company with limited liability under supervision of CMB. OPEX of the management company will be paid adding a margin of [••] bps on CBs interest rates Potential solution for breakdown of CIE equity ▪ CIE equity is divided within participating borrowing banks, according to their local market share ▪ CIE equity is divided within participating borrowing banks on an per-capita basis “Pro-rata” “Equal share” | 70 3 Cover pools Eligibility criteria Description ▪ Residential housing loans with, e.g. – First rank lien – LTV lower than 80%, calculated based on independent appraiser valuation – Insurance against fire and earthquake for the entire term of the loan – Collateral within geographical boundaries of Turkish Republic and with “habitation certificate” ▪ Less than [••] years (preliminary hypothesis could be 30-years) ▪ Less than TL [••] of capital remaining due (preliminary hypothesis could be less than 1÷1,5 million Turkish Lira) ▪ Minimum [••]% (preliminary hypothesis could be more than 125%) ▪ If loans of cover pool are repaid, borrower bank should replace them in the cover pool ▪ No single debtor shall represent more than [••] % of the total principal amount outstanding of the claims Largest [••] debtors shall not represent more than [••] % of the total principal amount outstanding of the claims Largest [••] debtors located in low GDP Turkish regions shall not represent more than [•]% of the total principal amount outstanding of the claims Type of eligible loans Maximum residual terms of eligible loan Maximum amount of eligible loan Over-collateralization No pre-payment risk Concentration ▪ ▪ | 71 4 Banks need track and separately manage cover pools to match the cash flows of covered bonds Principal payment 100 per value, 10% interest rate, 25% over collateralization Amortizing bond Bullet bond ▪ Cash inflows are not always a constant due to portfolio structure, prepayment, delinquency etc. ▪ Overcollateralization supplies enough buffer to overcome these issues 33 33 33 33 Monthly mortgage payment received 20 Bank Covered bond coupon payment (typically quarterly or semi annually) 1 16 26 Interest payment 33 30 23 25 27 2 3 4 5 18 20 22 24 26 26 26 Mortgage payments happen on a monthly basis, rather than yearly basis; hence there is a need for reserving and investing monthly mortgage payments to match annual/semi-annual CB payments Overcollateralization by 26 25% 26 ▪ ▪ ▪ 33 33 33 33 Monthly mortgage payment received Overcollateralization 33 26 25 30 23 27 20 1 2 3 4 5 10 To be reserved for bullet payment Years Years Bank Covered bond coupon payment (typically quarterly or semi annually) Bullet vs amortizing profile will be investordriven Bank treasuries will be responsible for ALM in case of cash flow mismatch Interest rate swap can be leveraged to mitigate timing mismatches between cash flows 100 Part of mortgage payment must be reserved and invested at a minimum interest rate at 10% to cover bullet payment, which might cause interest rate risk | 72 5 Liquidity facility Description ▪ The programme is able to draw a liquidity facility to meet: – Any interest payment shortfalls on the PBs for at least [•] year(s), in case of default of a CB’s – Any extraordinary expenses up to an equivalent of [•]% of the defaulted amount ▪ CIE enters into a liquidity facility agreements with the liquidity provider(s) in order to ensure the appropriate liquidity support in the event of CBs defaulting ▪ Each series has its own specific credit limit within the liquidity facility, which is defined prior to any new or tap issuance, and must be in line with Rating Agency criteria under stress scenario associated to the rating of PBs | 73 6 Waterfall of payments 1. Expenses, taxes and general costs 2. Interest accrued on the bonds 3. Remuneration of the liquidity facility 4. Reimbursement of the liquidity facility 5. Principal on the bonds 6. Any excess proceeds to Originators (once PB is liquidated) | 74 10 Rating of each series of programme bond Extract from FitchRatings methodologies Description ▪ Fitch's rating approach to multi-issuer covered bonds is based on 4 pillars: – Strength of the Originators Banks – Quality of the Cover Pools – Obligor Concentration – Default probability of the rated notes due to not timely receipt of interest and not full redeem of principal by final maturity date ▪ Fitch has defined a 3steps rating process for multi-issuer covered bonds SOURCE: FitchRatings 1 Test Liquidity Facility 2 3 Test available OC at all CB Issuers ▪ This output is used ▪ This output is used to to assess whether the liquidity facility can support interest payments during a one-year period on the portion of the CB portfolio that is assumed to default in the relevant rating scenario ▪ test if the available collateralization supports a recovery rate of 100% in the event of a CB default Fitch estimates the cover pool expected losses due to credit risk and liquidity risk: ‒ The credit losses are applied to the full cover pool ‒ The surviving (nondefaulted) amount is subjected to a liquidity risk loss applied in the form of an additional haircut on the cover pool's face value Assigning Ratings ▪ The rating assigned to ▪ the PB series addresses both timely interest and ultimate principal payments at the target stress scenario For example, if the transaction provides for timely interest payments in a “AAA” scenario but the collateralisation in place can only support 100% recoveries in the “AA” scenario, the transaction's maximum achievable rating would be “AA” | 75 10 Covered bonds are higher rated and sold at lower yields compared to senior unsecured bonds by Banks – France example 5-year maturity Company 10-year maturity Issue date Rating Yield 22.04.2010 AAA 22.04.2010 Issue date Rating Yield 2.60 06.01.2011 AAA NR 3.34 21.02.2011 08.11.2010 AAA 2.91 21.10.2010 A+ 3.95 SOURCE: Bloomberg Company 12-year maturity Company Issue date Rating Yield 3.77 10.10.2011 AAA 4.02 A+ 5.32 04.11.2011 NR 4.39 07.06.2010 AAA 3.78 15.02.2011 AAA 3.96 16.06.2010 NR 5.72 17.01.2011 NR 5.96 30.08.2011 AAA 3.91 22.09.2011 A+ 5.22 | 76 Key economics – the covered bond return has been estimated net of all issuance costs Key Key assumptions assumptions Methodology Analysis items Bank return from covered pool Bank costs Net return of bank Investor yield Return from issuance Return from proceeds Total return Explanation ▪ ▪ ▪ ▪ Interest rate paid by borrowers – total revenue coming from mortgage pool Costs associated to servicing of mortgages, cost of capital, cost of risk, required reserves and CB issuance ▪ Size: Around Şekerbank issuance size – scalable enough to dilute issuance costs ▪ Maturity: 5 years ▪ Pool interest rate: sensitivity to different rates ▪ Rating: At least A3 rating by Moody’s – More than Şekerbank covered bond issuance ▪ All option and swap costs are market costs of December 2011 Return of bank after its internal costs Yield requested by investor for a covered bond in Turkey including swap costs Explanations ▪ Residual left to bank from the transaction ▪ Average return of bank from the proceeds – calculated using overall return on assets ratio ▪ Real return of covered bond issuance ▪ ▪ After issuance bank gets funding from investor which can be used in another investment instrument ▪ We heard from banks that mortgage product is not profitabile, but rather used as a customer acquisition/retention product which enables cross-selling We should include possible additional income to be realized over the mortgage customer through the fund provided by issuance As a proxy, we used the return on assets of banking sector to estimate the additional return from mortgage customer | 77 Covered bond poses a comparable financing source with a possible additional yield for the bank depending on market situation Proceed return Breakdown of covered bond economics – local investor base Interest swap takes place to convert fixed yield to floating Bps, December 2011 1,300 100 10 40-60 8-10 40-60 Investor expectation of Gov + 50-100 bps corresponds to TRLIBOR + 20-70 bps 2 30-40 1,050 – 1,100 TRLIBOR + TRLIBOR + 70-120 bps 20-70 bps + Cost of capital is the opportunity cost of putting aside the capital banks need to hold to give the loan2 Estimation for average return coming from proceeds of issuance – calculated as income/total assets 200-220 0-100 Revenue from covered pool Cost of capital Cost of risk 0.5% NPL1 and 20% LGD ratios are assumed to calculate credit risk Option for Required refinancing reserve cost Consists of both upfront and running costs Servicing costs Issuance costs Net revenue Swapped Investor net yield revenue Return from covered bond Return from proceeds3 1 MBS should give 50-100 bps above t-bill to be appealing Pension fund 1 Non-performing loan ration in mortgage loans 2 Risk weight of a mortgage loan is 50%, the capital adequacy ratio limit is 12% and ROE of banks is calculated to be ~15% 3 Income before tax of banking sector in October 2011 is extrapolated and divided by June 2011 banking balance sheet (average of the year) SOURCE: Banks, Bloomberg | 78 Positive return Negative return Base case 1 Expected return from covered bond issuance changes with different mortgage yields and investor expectations Sensitivity analysis Covered bond economics Mortgage return of the cover pool – differs from bank to bank Issuance profitability including return from proceeds Investor spread on top of t-bill 1,300 Profitability Mortgage return of issuance Percent 200 10% 11% 12% 13% 14% Investor spread 25 -25 75 175 275 375 Bps 50 -50 50 150 250 350 75 -75 25 125 225 325 100 -100 0 100 200 300 125 -125 -25 75 175 275 150 -150 -50 50 150 250 with proceeds ~250 1,000-1,050 Profitability without any return from proceeds 200-220 Issuance profitability without proceed returns 200-300 Bank costs1 Investor yield Return from issuance Mortgage return of issuance Percent -10 10% 11% 12% 13% 14% Investor spread 25 -235 -135 -35 65 165 Bps 50 -260 -160 -60 40 140 75 -285 -185 -85 15 115 100 -310 -210 -110 -10 90 125 -335 -235 -135 -35 65 150 -360 -260 -160 -60 40 without proceeds 0-100 Mortgage revenue Profitability Return from proceeds Profitability of issuance Sensitivity analysis conducted to understand how profitability changes with changing mortgage return and spread 1 All costs falling on banks side SOURCE: Banks | 79 1 Liquidity constraints can boost mortgage prices – evidence from selected EU countries Spain mortgage loan rates Italy mortgage loan rates Percent Percent 3.25 3.75 Mortgage loan rate increase during the peak of crisis 3.20 3.15 Mortgage loan rate increase during the peak of crisis 3.70 3.10 3.65 3.05 3.00 3.60 2.95 2.90 3.55 2.85 2.80 3.50 2.75 2.70 1/10 4/10 7/10 10/10 SOURCE: Bloomberg, Bank of Italy 1/11 4/11 7/11 10/11 3.45 1/10 4/10 7/10 10/10 1/11 4/11 7/11 | 80 10/11 1 Under certain market conditions, covered bond is a better financing source for mortgages as its proceeds can be utilized for further loans Funding cost comparison Funding sources 1,300 Sensitivity analysis 1,200-1,300 ▪ The difference between returns is independent from mortgage revenue ▪ ▪ 200-220 Covered bond issuance 200-300 In our sensitivity analysis, we are trying to identify when covered bonds become more profitable than traditional funding (e.g., time deposits, interbank lending etc.) For the analysis we chose 2 variables: – Average funding cost – Investor spread expectation (on top of government yield) In the table, numbers represent the difference between traditional funding and covered bond funding: 0-100 Mortgage revenue 1,300 All-in-costs Return from issuance Traditional funding is more profitable Return from proceeds Covered bond issuance is more profitable Return from covered bond funding Base case Return 900-1,000 Average funding cost difference Investor spread ~100 ~100 100-200 (above t-bill) Bps Traditional funding Mortgage revenue Cost of funding Cost of capital Other costs1 Return from traditional funding Percent 10 9,0% 9,5% 10,0% 10,5% 11,0% 0 110 160 210 260 310 50 60 110 160 210 260 100 10 60 110 160 210 150 -40 10 60 110 160 200 -90 -40 10 60 110 1 Includes option, servicing and reserve costs and cost of risk SOURCE: Banks, Bloomberg, TBB | 81 2 Interest rate swap from fixed to floating rate is required to ensure that bank satisfies investor requirements Interest rate swap from fixed to floating rate Cover pool yield ~10,6% Investor yield TRLIBOR + 70-120 bps Gov + 50-100 bps TRLIBOR + 20-70 bps Rationale ▪ Mortgage loans in Turkey are generally fixed rate ▪ Investors request a floating return from their covered bonds: Government bond yield + 50-100 bps ▪ Banks need to hedge this interest rate risk as these bonds have long maturities Fixed return from cover pool ▪ ▪ Investor expectations Floating investor expectations Banks give fixed interest and swap partner provides a floating interest Expected investor yield can be swapped into TRLIBOR + 20-70 bps in the current IRS market Floating yield in exchange with different fixed cash flows in IRS market 9.9% 10.0% 10.5% 11.0% 11.5% SOURCE: Bank treasuries, interviews Floating return from cover pool TRLIBOR TRLIBOR + 10 bps TRLIBOR + 60 bps TRLIBOR + 110 bps TRLIBOR + 160 bps | 82 Contents ▪ Need for a Capital Market solution for the mortgage market in Turkey ▪ Proposed Capital Market solutions and key economics ▪ Summary of results from first meetings with key stakeholders ▪ Proposed implementation roadmap | 83 A set of structured stakeholder interviews are conducted to develop capital market solution Related main stakeholders ▪ Visits to market players and regulators ▪ We targeted following topics in each visit: CMB – Understanding the infrastructure (past) for project solution ▫ Need for secondary mortgage market ▫ Best international practices ▫ Investor appetite (will) ▫ Current legislative framework Market players Treasury ▫ Market challenges/hurdles – Design of proposed capital market solutions – Possible roles of government, regulators and banks BRSA | 84 Banks indicate that they are aware of the need but they don’t have bias for leadership Key messages Issuers and investors – Main constituent players of market Private and public enterprises visited ▪ Overall appetite ▪ ▪ CMB Market players Treasury BRSA SOURCE: Interviews Implications on Capital market solution design What they told us? Mortgage market is small, so ▪ currently banks can fund through shorter term financing Going forward maturity mismatch will pressurize banks Sustainable local investor demand ▪ Investment limit ▪ Restrictions for portfolio ▪ allocation to securities other than government bonds None – Key requirements are more flexible compared to other EU countries ▪ Competition ▪ Competitor banks would not buy single originator bonds, multioriginators preferred ▪ Central solution ▪ Capital benefit ▪ Higher capital adequacy requirements ▪ Requirements are in line with European regulations ▪ Cash flow ▪ management Not repo-eligible in contrary to international benchmarks ▪ Need for government/regulatory involvement ▪ Regulatory hurdles ▪ Delays (1 month or so) occur due to regulatory hurdles ▪ CMB is not the bottleneck ▪ Customer relationship ▪ Mortgage loan is an anchor product, critical for customer retention ▪ Service provider role ▪ Overall appetite ▪ Investor expectation for the pricing of normalized Italian and Spanish MBSs over 100 bps ▪ Still profitable for funding banks ▪ Currency risk ▪ ▪ Currency is still a concern Real money investors would be interested only if in Euro or USD denominated ▪ Additional yield to investors to cover currency swap | 85 CMB showed great interest in kick-start of secondary mortgage market and indicated to lead this entrepreneurship CMB has critical importance in terms of legislative framework Key messages ▪ ▪ CMB ▪ Market players Treasury ▪ BRSA SOURCE: Interviews ▪ CMB is planning to update regulations on covered bond, RMBS and other asset-backed securities. These updates will be useful for all participants of secondary mortgage market CMB is planning to design these updates according to secondary mortgage market practice outcomes CMB is proposing to broaden beneficiary spectrum by including Housing Development Administration (TOKİ) and other possible construction companies CMB also accepted the importance of a systematic solution and focused on market liquidity Furthermore, CMB indicated to lead the kickstart of secondary mortgage market | 86 Treasury is supporting central solution idea but will be an abstainer until some prerequisites are fulfilled Treasury for government support Key messages ▪ ▪ CMB Market players Treasury ▪ BRSA SOURCE: Interviews Undersecretariat of Treasury is also supporting systematic solution because of organized and standardized approach But in current situation, some fundamental obstacles/hurdles must be overcome before taking its support, such as: – Assessing public obligations of the process regarding mortgage loan levels keeping up with current public debt as a result of mortgage increase due to GDP penetration – Risk of secondary mortgage market tools competing with government issuances in case of treasury guarantee – Current legislative framework of treasury not covering reassurance of private enterprise issuances Treasury will be more motivated to support only after some prerequisites are fulfilled, e.g., listing participant banks, establishing CIE administration, clarifying risk management procedures, etc. | 87 BRSA is supporting central solution idea due to its utilization for developing/improving banking sector balance sheet BRSA is planning to provide financing space to banks Key messages ▪ BRSA is supporting the idea of alternative funding sources to fulfill future capital needs ▪ Furthermore, supporting funding solutions at RMBS level (securitization) which are important in terms of banking sector balances ▪ In midyear, when Basel II will be implemented as planned, application of an exceptional capital efficiency ratio to related funding tools in order to settle the disputes with Basel overseers may lead to problems due to increasing procedures. This is the main reason they refused to support this idea CMB Market players Treasury BRSA SOURCE: Interviews | 88 Contents ▪ Need for a Capital Market solution for the mortgage market in Turkey ▪ Proposed Capital Market solutions and key economics ▪ Summary of results from first meetings with key stakeholders ▪ Proposed implementation roadmap | 89 Required implementation plan for kick-starting secondary market for mortgage loans 1. stage: Preparing the “Program” Finalizing (CIE) structure ▪ ▪ ▪ ▪ ▪ Defining legal structure Developing organization structure (including management company) Developing corporate management strategy Identifying capital requirements Developing methods for pricing structure and cost allocation between stakeholders Designing fundamental factors of daily CIE operations ▪ ▪ ▪ ▪ ▪ ▪ Improving critical processes (developing, restructuring, allocation, monitoring) Designing risk management policies and procedures Developing organizational scheme (including roles and responsibilities) Developing performance management systems (including incentive methods) Developing IT systems Preparing rating package 2. stage: Launching Defining program strategy ▪ ▪ ▪ ▪ Defining 5 year targets for program (also based on application of “eligibility criteria” to stakeholders’ credit portfolios) Economic/financial definition of program Assessing stakeholder oriented main benefits/impacts Market research with potential investors Expectations from banks in establishment of secondary mortgage market: ▪ Related support for the process and leadership ▪ Providing required capital for secondary mortgage market ▪ Allocating required resources/building work force for the transition Detailing the program ▪ ▪ ▪ ▪ ▪ ▪ ▪ ▪ Defining possible improvements required ▪ for assignment criteria of participant banks via “Gap analysis” Identifying and tacking ▪ possible “external” factors (if available) e.g.,: Repo program, regulations specific to this topic, etc. Specifying program bond ▪ issuance details (establishing the mechanism, serial properties, size) Specifying details of bank’s covered bond cover pool ▪ (eligibility criteria, cover pool limits, over collateralization etc.) Defining program bond criteria (type of interest rate, payment scheme) Specifying payment flow type Designing liquidity method (mechanism, limits) Developing monitoring process and improving service reports Defining and finalizing regulatory requirements Registration of CIE due course of laws/legislations of regulatory bodies Developing detailed reporting and monitoring requirements for CIE activities Defining roles and responsibilities of program bond investors and their representatives Approval of program by regulatory bodies Launching ▪ ▪ ▪ ▪ ▪ Establishing CIE Initial issuance Selecting related parties and assigning as representatives Rating First transactional investment | 90
